Sitio Royalties Q2 2023 Earnings Call Transcript

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August 9, 2023

There are 9 speakers on the call.

Operator

Morning and thank you for joining the CTO Royalty's Second Quarter 2023 Earnings Call. My name is Carla and I will be the operator of today's I would now like to pass the conference over to our host, Ross Wong, Vice President of Finance and Investor Relations. Ross, please go ahead when you're ready.

Speaker 1

Thanks, operator, and good morning, everyone. Welcome to the City of Royalty's Q2 2023 earnings call. If you don't already have a copy of our recent press release and updated investor presentation. Please visit our website at www.cidio.com, where you will find them in our Investor Relations section. With me today to discuss Q2 2023 financial and operating results is Chris Conoscente, our Chief Executive Officer Kirio Cica, Our Chief Financial Officer Jarrett Marcu, our EVP of Engineering and Acquisitions and other members of our executive leadership team.

Speaker 1

Before we start, I would like to remind you that our discussion today may contain forward looking statements and non GAAP measures. Please refer to our earnings release, investor presentation and publicly filed documents for additional information regarding such forward looking statements and non GAAP measures. And with that, I will turn the call over to Chris.

Speaker 2

Thanks, Ross. Good morning, everyone, and thank you for joining Cythio's Q2 2023 earnings call. Following a quiet Q1 of this year, we are excited to share some success we had with recent acquisitions. In the past 2 months, we have closed on 5 accretive acquisitions in the Permian Basin for aggregate consideration of approximately $248,000,000 We funded one of these transactions with approximately 2,500,000 shares of Scitio stock in June. In July August, we signed and closed the remaining 4 acquisitions with $181,000,000 in cash, representing 27% equity 73% cash in total.

Speaker 2

These transactions were with sellers that we know well and have had relationships with for a number of years. And the stock transaction in June was with a seller that has taken our equity in exchange for assets before. This relationship based approach to generating and executing on minerals acquisition is a true differentiator and has been a staple of our growth strategy for many years. We acquired these assets for less than 7 times next 12 months cash flow and, in aggregate, expect them to be approximately 6% accretive to our second half twenty twenty three discretionary cash flow per share at current strip pricing and a payout ratio of 65%. The acquired assets are highly complementary to our existing portfolio, as you can see on Page 7 of our earnings presentation, and in total, added 13,000 705 NRAs or 7% to our Permian Basin position, with 82% of the NRAs in the Delaware Basin and 18% in the Midland Basin.

Speaker 2

The acquired assets also had 2.6 net spuds and 1.1 net permits for a total of 3.7 net line of sight wells as of June 30. In aggregate, the acquired assets produced An estimated 19 18 BOEs per day during the Q2 and have a similar mix of existing production and remaining locations As our legacy Permian Basin assets. Although we were successful recently in closing these five deals, we still see the M and A environment as extremely competitive. During the Q2 of 2023, CITIO's assets averaged a record high of 34,681 BOEs per day, Which included 17 days of production from the stock acquisition that closed in June. Production from Scitio's mineral and royalty assets Has grown each quarter since we became public last June.

Speaker 2

Including a full quarter of production from all of the recently acquired assets, Scitio's 2nd quarter production would have been 36,462 BOEs per day or 1781 BOEs per day Higher than reported. We estimate that pro form a for these newly acquired assets, there were 8.1 net wells Turn in line during the quarter and an all time company high of 50.8 net line of sight wells as of June 30. From a geographic perspective, our pro form a net line of sight well increase came from 61% in the Delaware Basin, 16% in the Midland Basin and 23% in the Eagle Ford, with the rest of our basins relatively flat on a combined basis. I would now like to turn the call over to Jarrett Marcou to make some comments on the macro backdrop and activity on our assets.

Speaker 3

Thanks, Chris. As Chris just mentioned, we have 50.8 net line of sight wells, 47.1 of which are from our asset excluding the acquisitions just discussed. This compares to 42.8 net line of sight wells at the end of Q1 on a like for like basis. This quarter over quarter organic increase of 10% in net line of sight wells is encouraging for near term production visibility. Despite a material slowdown in rig counts over the last quarter across the U.

Speaker 3

S. And in the Permian Basin of 12% 8%, respectively, The rigs on our acreage during the same time frame have been flat. However, we believe that rig count on our acreage will eventually moderate if rates continue to be dropped overall. Well production rates are in line with our expectations and our PDP decline rate over the next 12 months Is 32.4 percent pro form a for the recent acquisitions. This is comparable to our decline rate of 32.7% prior to the acquisitions.

Speaker 3

According to EIA estimates, DUCs in the Permian are down by 73 from 930 to 857 between March June of 2023 and at their lowest level since July of 2014. This quarter over quarter drawdown of 73 DUCs The lowest amount since the DUC drawdown began in the fall of 2020 when there was an average change of 384 DUCs a quarter. There were 3,519 DUCs at the peak of the DUC buildup in July of 2020. So the current level of 857 DUCs Is nearly a quarter of that high mark. These data points give us confidence that the DUC drawdown is nearly over And that future production from our assets will be tied more directly to rig activity compared to the past couple of years, which was somewhat misleading due to the tailwinds from the DUC Our second half guidance, which Chris will discuss in a moment, are informed by these macro as well as asset level trends.

Speaker 3

Now I'll turn it back over to Chris to discuss Sidio's financial results and second half twenty twenty three guidance.

Speaker 2

Thanks, Jared. Moving on to our financial results. Reported 2nd quarter adjusted EBITDA of $127,000,000 and discretionary cash flow of $95,000,000 Which were down by 9% 21%, respectively, relative to the Q1 of 2023. Much of these variances were driven by pricing as our average Hedged realized price per BOE for the Q2 was $44.45 a 9% decrease compared to 1Q 'twenty three. Quarterly cash G and A was up by just over $500,000 primarily due to salary expenses and the timing of vendor payments.

Speaker 2

For the first half of twenty twenty three, our cash G and A was $12,800,000 which is tracking just below The midpoint of our full year guidance, assuming a run rate of $13,000,000 for half a year. Our 2nd quarter discretionary cash flow was impacted by changes in Cash taxes and cash interest paid during the quarter. Cash taxes were up $7,700,000 relative to the Q1, primarily due to $5,900,000 of taxes that were paid in April but related to the Q1. Quarter over quarter cash interest was up by $4,500,000 was driven by a $2,700,000 interest payment related to the Q1 borrowing that was paid in the Q2 and also due to higher sulfur rates. Our Board declared a dividend of $0.40 per share of Class A common stock for the Q2, which will be paid on August 31st To record holders at the close of business on August 18.

Speaker 2

This dividend is down by $0.10 per share relative to the prior quarter, primarily due to the factors I mentioned during my discussion Our second quarter dividend was $0.015 per share higher than it otherwise would have been Due to the inclusion of a full quarter of cash flow from the stock acquisitions that closed in June, providing immediate accretion for our shareholders. Regarding the balance sheet, At the end of June, we made our 3rd consecutive amortization payment at par of $11,250,000 on our unsecured note, Reducing the remaining principal to $416,300,000 Our ending credit facility balance on June 30 was $486,000,000 Which was comparable to the amount drawn at the end of the Q1, even though we drew on the RBL in June to fund a portion of the cash acquisitions that closed in July August. Since then, we have funded the remainder of our recent cash acquisitions using our revolver and cash from operations. As of August 7, we had an outstanding revolver balance $605,000,000 We are issuing new operational and financial guidance for the second half of twenty twenty three to reflect the impact Of our recent acquisitions and the macro backdrop that Jared discussed earlier.

Speaker 2

Compared to our previous guidance for the full year 2023, We are increasing our production guidance for the second half to 35,000 to 37,000 BOEs per day and reducing our gathering and transportation guidance range. We have also been advised by our tax consultants that we should expect minimal cash tax payments for the rest of the year Due to a tax benefit from 2022, therefore, we have provided a cash tax guidance range of 2% to 4% of pretax income for the second half of the year. We expect this benefit to last through calendar year 2023 and for cash tax rate to shift back to the normal 11% to 13% range afterwards. All other guidance metrics remain in line with prior full year 2023 guidance. That concludes our prepared remarks.

Speaker 2

Operator, please open up the call for questions.

Operator

Thank you. Our first question comes from Tim Rezvan from KeyBanc Capital Markets. Your line is now open, Tim. Please go ahead.

Speaker 4

Good morning to the team there. I guess, Chris, my first question, We're trying to kind of make sense of the production impact and the earnings impact from acquisitions and the call. Sort of the updated guide, it looks like you're adding about 6% production in EBITDA from these deals. We thought we might see a little more of an uptick call. In the guidance and you talked about the accretion.

Speaker 4

So is there sort of a timing factor with sort of the line of sight wells? This is more of a Q4 or 2024 benefit that you see. I was wondering if you could kind of talk through the dynamics on the production guide and the acquisitions.

Speaker 2

Yes. Good morning, Tim. Thanks for the question. So good news is we're not seeing any degradation in timing for Spud to turn in line or permit to spud to turn in line, that has remained relatively constant for those timelines. But we did look at our prior guidance, which had a midpoint of 35,500 BOEs per day.

Speaker 2

And If you just look at that relative to the first half of the year and ask yourself what would you have to believe for the back half of the year, you'd have to see greater than 5% growth In the back half of the year and on the base asset, we just as you can look across the entire Permian Basin, we just aren't seeing that kind of growth. It's more flat or low single digit kind of growth on the base asset. The good news on the acquisitions is Higher spud activity and visible near term development on those. So yes, we do see the accretion around 6% from The acquisitions, we're excited about that. And the valuation at which we got them was very compelling at less than 7 times next 12 months cash flow.

Speaker 2

So Lots to be excited about around the acquisitions and filling in some more growth in the back half of the year.

Speaker 4

Okay. I appreciate the context. And then I was just wondering, you know, Viper came out on their call announcing The change in the governance structure to allow for broad index inclusion. I know that's something that management and the Board has You've been thinking about, so just curious kind of what your thoughts are on that potential for Sidio in the future?

Speaker 2

Right. So, CITIO is already a C Corp, so we're already index eligible. And like Viper, we just we don't know the timing of When any index inclusion could come. And the other development that happened in the last few months, I'm sure you saw was The S and P indices now allow for companies like ours that have an Upsea structure to be included in the indices. Previously, we were ineligible from index inclusion in the S and P indices because of our Up C structure, But they recognize that the Class A and Class B shares have equal voting rights and equal economic rights in the dividend as call.

Speaker 2

Class A shareholders. So they now allow for index inclusion for companies like ours, but we don't have to change our structure or anything. We are already a C Corp. So we didn't have to convert from a partnership.

Speaker 4

Okay. Thanks. I wasn't aware of that

Operator

Thanks, Tim. Our next question comes from TJ Schultz from RBC Capital. Your line is now open. Please go ahead.

Speaker 5

Hey, good morning. First on the M and A, on the 5 deals you transacted over the last couple of months, was the stock deal the largest? I know you've indicated in the past, obviously, more call. Impact from larger type transactions. So just how would you bracket what you characterize as larger deals?

Speaker 5

Is it $100,000,000 call. And then how many of those packages do you think are out there? And Chris, I think you commented it's still fairly competitive. So if you could just Give some color on how you expect that to transpire the rest of the year? Thanks.

Speaker 2

Sure. Thanks, TJ. Good morning. The stock transaction was not the largest individually of the 5, but on its own the stock deal as you probably saw from the filings that The seller made it was about $65,000,000 with the stock price at closing there. So it was a Meaningful deal, but I wouldn't call it large.

Speaker 2

Large for us gets north of a few $100,000,000 So we would characterize all these individually as relatively small, But impactful as you can see from the accretion and evaluation at which we were able to acquire them, you asked how many were out there and what competitive dynamic looks like for the very large transactions, the ones that are sort of ballpark $1,000,000,000 or larger, I would say there's a couple dozen. For the ones that are $500,000,000 to $1,000,000,000 range, there you're talking literally dozens and dozens. So we see a lot of We're in discussions with a lot of those owners like we have been for years and that's exactly how these transactions played out this past 3 months. These were Several of these were ones where we've been talking to the owners for upwards of 4 years. So These relationships take a long time to cultivate and we have to find that right time when the seller is ready and when the valuation is right for us.

Speaker 2

So in terms of the competitive dynamic, obviously we see the most heated competition in those Situations that are broadly auctioned and that's why we have very, very limited success in those situations. We tend to do a lot better where we have a relationship with sellers and can Align ourselves better on data and talk directly with them and figure out a solution that works best for both parties in terms of valuation, consideration mix, etcetera. So we continue to focus there. We do look at some of these auctions, but we have been unsuccessful this year in these broad auction processes. As you can see in some of the things that have transacted, we've been off by between 15% 100% on some of the things that have transacted this year.

Speaker 2

So We're going to continue to focus on the relationship based approach.

Speaker 5

Okay. Makes sense. I guess just lastly on the tax guidance, maybe just a little color on what caused that change for this year. Is there a catch up next year? And does any of the M and A transacted this year push it out any further?

Speaker 2

Sure. Yes, Kerry can supplement what I say here, but effectively it was a tax benefit that resulted from Brigham And it carried over to this year and our tax advisers have informed us that the back half of this year should result in Minimal to no federal income taxes for us because of the credit from 2022?

Speaker 6

That's correct, Chris. We will still have state income tax and margin tax, but other than that, yes, we don't expect to be paying federal taxes, Significant payments until next year again.

Speaker 5

Okay. I guess just one more, just to kind of clarify again on the production guidance for the back half of the year. I think in some of the macro comments you all made, You mentioned that rigs on your acreage has held in better than kind of what we've seen on some of the Have my numbers, so your rigs are holding in about flat. Just to be clear, your assumptions kind of driving The production range is assuming that rig activity on your acreage normalizes closer to what some of the declines you've seen, Is that fair? And then I think you're indicating that it should correlate more closely to Rig activity, just given what we've seen on the DUC drawdowns, am I framing that right?

Speaker 2

I'll make a couple of comments there and ask Jared to share his thoughts. Historically, what we've told you is that relying on just gross rig activity can be very deceptive and misleading just given 1, you don't know the NRI of the wells being drilled and 2, you don't know where and what basins Co. Those rigs are active and so a well in Appalachia is going to be call. A different impact than a well in the heart of the Midland Basin. So a few key things to pay attention to there.

Speaker 2

But I'll let Jared chime in on his thoughts on the trending in the rig count and impacts on our asset base in the future.

Speaker 3

Yes. Thanks, Chris. TJ, as far as the rigs are concerned, like we mentioned in the comments, let's say Permian, for example, Rigs are down just below 8% over the last quarter. And typically when rigs pull back in these type of macro environments, They pull back from the edges of the basin. If you imagine the basin is these big ovals, they kind of get smaller.

Speaker 3

Most of our acreage is concentrated in the heart of the basin and especially Our higher concentration of our acres in that gross footprint is towards the fairways of the basin. So if rigs are down 8%, We expect moderation on our asset going forward, but probably not to the extent that it's happening in the basin for the reasons I just mentioned. So when we think about the macro backdrop, we don't believe that we're going to get 0 effect of the macro backdrop, We think will be not directly correlated to what's happening in the rig count.

Speaker 5

Okay. No, that makes sense. Thank you.

Operator

Thanks, TJ. Our next question

Speaker 7

Hi. This is Nate Pendleton from Stifel. Thanks for taking my questions. For my first question, can you provide any color on how the Current commodity price environment is impacting your team's outlook for acquisitions?

Speaker 2

Good morning, Nathan. Thanks for the question. The short answer is not very impactful in terms of how we look at acquisitions. We underwrite acquisitions In a base case looking at the strip and we don't pretend like we're any smarter than the strip, we do sensitize it down, but Our underwriting standards remain the same regardless of the commodity price environment.

Speaker 7

Got it. Thanks. And for my follow-up, regarding return of capital, can you discuss some of your considerations when you're assessing the right longer term mix Now that your unsecured notes have been amended?

Speaker 2

That's a good question. We did have some success with our unsecured note holders And securing an amendment that would allow us to buy back $25,000,000 of stock Above and beyond our 65 percent dividend payout, our Board has not yet authorized a buyback program. We're watching closely On the stock's behavior to see what the right timing is. But the other thing we think about in that context is our leverage and liquidity. And as you can see from the last 6 months, we've made some progress chipping away at the pre payable debt balances.

Speaker 2

We've made several payments at par on our unsecured notes. And then prior to these cash acquisitions in the last 2 months, we were paying down our RBL balance and we'd like to continue doing that and working towards our Long term goal of one times or less leverage, which will give us not the optimal balance sheet, but call. So I would say stay tuned for more to come on buybacks Under the current unsecured notes and then once we refinance the current unsecured notes, we'll have a different framework altogether.

Speaker 7

Thanks, Chris. I appreciate the color.

Speaker 2

Thanks, Nathan.

Operator

Thanks, Nathan. Our next question comes from Noel Parks from Tuohy Brothers. Noel, your line is now open. Please go ahead.

Speaker 8

Hi, good morning.

Speaker 1

Hey, Noel.

Speaker 8

So, with the acquisitions, Is it safe to assume that they fall sort of in your sweet spot of variable additional overhead for the new assets and co. Hopefully some leasing opportunities for the mineral.

Speaker 2

That's absolutely right. We added no overhead. There's actually a fair amount of overlap as you can see from the overlap map in our earnings presentation To our existing assets and yes, we do expect subsequent leasing opportunities on these assets like we see with all of our acquisitions.

Speaker 8

Great. And in the course of negotiating on the different deals, you talked a bit about Structure being something that is meaningful. Just are there any Sort of patterns you can draw as far as seller motivation at this particular juncture, how much price is Or isn't the sort of overriding factor?

Speaker 2

Yes, it's a good question. The Price is always the primary motivating factor. But when you look at transaction size, when you get to a larger transaction size, I think the sellers acknowledge that the cash capacity in the minerals market has limitations and therefore there will be a need to accept buyer stock as consideration. Now one unique exception to that was the stock deal that we did in June. I would categorize that as one on the smaller end and it happened to be A seller that had taken our stock in exchange for assets before.

Speaker 2

So somebody that knew our equity, understood our strategy And saw the upside in our company and wanted to take equity when they clearly could have sold for cash, but they Our equity instead. So occasionally, we see opportunities like that, but more frequently, we see that at the larger end of the deal spectrum.

Speaker 8

Got it. And just sort of a more general question. I feel like I've been hearing Generally more optimism about gas takeaway in the Permian and that easing as a potential issue that May Swart drilling activity or turn in line activity. I was wondering if you had any perspective on that?

Speaker 2

We do. If you look at the response that the gas market has had to infrastructure build out, it's encouraging Just when you look at Waha differentials, so if you look at projects that are already underway with the Whistler expansion, Permian Highway, With Matterhorn getting FID and other projects, you have upwards of 3.6 Bcf per day of new capacity coming on Over the next year, year and a half. And so that sends a strong signal to the gas market that there's egress coming out of the Permian Basin In a volume that you just can't see in other basins, 1, because there isn't demand for, but 2, just there's constraints politically, geographically, etcetera That will prohibit that from happening in other basins, but we're very, very fortunate in West Texas and Southeast New Mexico to have a much more constructive regulatory environment.

Speaker 8

Great. And just one other detail. I don't imagine if you're moving it either way, but I was just curious, Was there any hedging on the acquired properties that help maybe keep activity going when things are volatile?

Speaker 2

So we did not hedge any volumes from the acquired assets. We do look at hedging when we're Within that mid cycle band of $50 to $75 We discussed it, ultimately did not. Commodity prices are up since then. So I'm not saying we were right or wrong. It's just the approach we take is to consider it when we're in that band and then call.

Speaker 2

Definitively to hedge when we're above that band, but the decision was made on these acquisitions not to hedge the cash acquisitions. Regardless of what we do on hedging, it's not going to encourage or discourage more activity. It's really just to protect the returns that we underwrite And we feel like we had underwritten the returns in a manner such as didn't require the hedging support within that mid cycle pricing band.

Speaker 8

Okay, great. That's all for me.

Speaker 2

Thank you.

Operator

Thank you. There are no further questions registered at this time. So with that, we will conclude today's call. Thank you for joining. You may now disconnect your lines.

Operator

Have a great day.

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